European Financial Crisis

May 30, 2010

Fitch
downgraded Spain’s long-term foreign and local currency ratings by one
notch to AA+ from triple-A.According to the company:

“The downgrade reflects Fitch’s assessment that the process
of adjustment to a lower level of private sector and external indebtedness will
materially reduce the rate of growth of the Spanish economy over the medium
term,“ Brian Coulton of Fitch was quoted as saying in a statement.

May 29, 2010

Sachs is much more positive about the ability to bring PIIGS
deficits under control and avoid restructuring than other commenters.
Unfortunately, he doesn't elaborate on the reasons for such optimism.

The real reason I posted this, though, is because of the
beating Sachs takes for being an academic.First, Hendry makes fun of Sachs' position as a tenured
professor unexposed to the risk of the world.Then, he accuses him of skiing too much.

Yesterday, in How
Would Greece Restructure Now?, I asked Lee Buchheit (Cleary Gottlieb Steen & Hamilton) to
summarize the possible impact of the European Central Bank’s recent €26.5bn
government bond purchases on the possibility and mechanics of a Greek debt
restructuring.Today, frequent
guest Lounger Anna Gelpern (American, law) –see here and here for previous posts– chimes in
with her thoughts on the issue.

If the central banks are untouchably senior, if ECB and the
other central banks become dominant holders of Greek debt, and if the German
banking problem is not fixed, plus Greece takes on a ton of old-fashioned
senior debt (IMF) …then there is
not enough blood to be squeezed from the remaining bondholder stone.Therefore, restructuring becomes less
likely.Buy the bonds for the same
reason foreigners bought Boden, Argentine domestic debt held overwhelmingly by
Argentine banks—the government was at the time credibly committed not to sink
its banks (for its own domestic political reasons).Then we keep treading water until Axel Weber takes over the
ECB and in the Nixon-Goes-To-China mode, stops sterilizing and starts printing
money.The Euro drops (unless
today’s market is pricing total Euro disintegration, in which case the Euro
would go up because printing money is an exit from uncertainty), European
exports of cars, shoes, and yogurt skyrocket; European center and periphery do
a dance of unity as Detroit sinks.If I were investing in Greek debt, I would try to figure out just how
much debt is held by preferred and non-preferred creditors.There may be a point where I could
free-ride on the preference.

A separate point—since others on the Euro periphery are or
are about to be in the same boat, official creditors would face tricky
political questions of equal treatment.If you go all out to prevent a Greek restructuring (for example, because
all debt is with the ECB), could you ever force a haircut in Spain?This brings up the poor country
analogy.Poor countries’ creditors
were overwhelmingly official, and when too much debt was senior multilateral
plus Bono and the Pope got involved, there was a big concerted trip to the
barbershop (HIPC/MDRI).This leads
to the opposite conclusion from the preceding paragraph, and makes me think
that a formal debt restructuring mechanism in Europe is more likely than I had
previously thought.

And at another extreme, if it is true that Greek banks are
big buyers of CDS protection, say, from the Norwegian sovereign wealth fund,
Greece has a new incentive to default – its insolvent banks have one of the few
good counterparties left standing, burden-sharing heaven.This seems a little counterintuitive—banks
shorting their government?But
then again, local capital flight often leads crisis outflows.Even so, the total volume of CDS
outstanding is too small to plug the Greek banking hole. So …

May 28, 2010

A few weeks ago, we asked when
Greece would restructure and noted that the emerging consensus seems to be that
they will eventually have to do so. The real question is “when”? After
that, I
provided the “how,” as explained by Lee Buchheit (Cleary Gottlieb
Steen & Hamilton) and Mitu Gulati (Duke, law) in a paper recently posted to SSRN.Since then, as we’ve discussed here
and here,
the European Central Bank has purchased about €26.5bn of government bonds in
the past two weeks, and is anticipated to buy more. A few days ago, in Should
Greece Bail Out Germany?, I asked what impact these ECB purchases might
have on the possibility and mechanics of a Greek debt restructuring.

Today, frequent guest
Lounger (see here, here, and here for prior posts) and
sovereign debt expert Lee Buchheit is back with some answers:

The ECB's decision to buy Greek (and other Club Med country)
bonds for its own account is significant for several reasons.

First, they now have the wolf firmly by the ears.If the ECB suddenly stops buying
(or even starts selling), the market will know instantly and that could start a
stampede.But if they must
continue buying, where and when does it stop?

Second, if a restructuring eventually comes to pass, what
posture will the ECB take with respect to the bonds it owns?Will it, for example, try to
claim preferred creditor status (like the multilateral financial institutions),
or perhaps argue that its contribution at this stage was the functional
equivalent of debtor in possession (DIP) financing that deserves a priority in
any restructuring?

If the restructuring starts in, say, nine months, the Greek
debt stock will look significantly different from today.The IMF money will be senior and
exempted from the restructuring.

The bilateral money coming from the EU members may also try
to claim a preferred or semi-preferred status.It is, after all, one thing to jolly German
parliamentarians into approving a bailout package, it is something else again
to go back to them nine months later and announce that the package is being
given a haircut.

And then there is the status of the ECB as a
bondholder.Will it go
gentle into the good night of a debt restructuring, having bet the bank
(literally) that one could be avoided?

If all three groups try to assert a preference in the
restructuring, that will inevitably force the remaining bondholders to accept
much harsher terms.The
danger now is that those other creditors may begin to see themselves being
quietly subordinated with each Euro disbursed to Greece under the bailout
package, and with each Greek bond purchased by the ECB.

That perception alone should ensure some continued selling
pressure.

Third, in any restructuring the ECB is likely to be the
single largest creditor.This will give it significant voting power in bond syndicates with
collective action clauses.

May 26, 2010

Is the eurozone
insolvent? In the past few weeks, we have all focused on the solvency of
Greece, Spain and Portugal. But we never seriously questioned the solvency of
those who actually guarantee all those southern European debts.

Münchau argues that the question cannot be answered by
reference to the debt-to-gross domestic product ratios of eurozone countries,
because those numbers exclude contingent debt and the interconnectedness of
financial flows, and the biggest category of contingent debt are the guarantees
the eurozone has been making over the last few years.

European Union governments have effectively guaranteed the
liabilities of their entire banking sectors. They have guaranteed all bank
deposits up to a certain limit. The eurozone member states guaranteed Greek
debt for the next three years, and then extended the scheme to the rest of the
eurozone. And those guarantees will probably have to be doubled again. . . .

International Monetary Fund estimates suggest that the
eurozone is well behind the US in terms of writing off bad assets.

How far behind and how bad are the assets?Hard to know, but the chart at right by Alphaville’s Tracy Alloway shows the net foreign asset position
of banks in Germany, France, Italy and Spain.It indicates that German banks’ accumulation of foreign assets
has been growing substantially, likely due to developments in Landesbanken —
Germany’s public sector banks — in the first half of the last decade. According to Alloway, in 2001, the
European Commission abolished
state guarantees for the Landesbanks, but the institutions were granted a
four-year adjustment period.

To counter, or prepare for the loss of the state guarantees,
the Landesbanks went on something of a shopping spree — snapping up high-yield
assets, the effect of which you can see in the chart.

Finally, Gillian
Tett reports on the release last week by Barclays Capital of “the latest
part of a long-running survey of Japanese bond investors, which tries to determine
attitudes towards dollar and euro bonds.” The report revealed that two-thirds
of Japanese investors fear that the latest €750bn aid package will have “not
much” impact on the eurozone’s problems – up from just one-third of investors
that expressed skepticism two weeks ago (when the package emerged).

Investors also expressed fear about euro bonds:

at the start of the year almost 80 per cent of the survey’s
respondents preferred euro debt to dollar debt, but that proportion is now
below 30 per cent.

Japanese investors are not just worried about debt issued by
the peripheral economies of Portugal, Italy, Ireland and Greece; they seem
pretty uneasy about German bonds too.

As long as the eurozone governments can generate sufficient
tax revenues, all is well. But if that were to stop, the eurozone’s debt
edifice might break down like a house of cards. Even a 150 per cent debt-to-GDP
ratio would be feasible if the eurozone had an intelligent growth strategy. But
it never did, and it still does not.

Meanwhile, Germany has proposed extending
its short selling ban to all German stocks and certain euro-currency
derivatives. (A hearing on the draft is scheduled for May 27 in Berlin.) And
the European
Central Bank announced that it purchased another €10bn of government bonds
in the last week, bringing its total purchases to about €26.5bn in the past two
weeks.

I guess some folks, God help them, actually believe that bans
on short selling, the suspension of mark-to-market accounting, and shifting the
risk of European periphery debt from individual European financial institutions
to the central bank will fix Europe’s ills.

I’ll be back later with more about the ECB bond purchases,
particularly the potential impact on a debt restructuring.

May 23, 2010

PARIS — Across Western Europe, the “lifestyle superpower,”
the assumptions and gains of a lifetime are suddenly in doubt. The deficit
crisis that threatens the euro has also undermined the sustainability of the
European standard of social welfare, built by left-leaning governments since
the end of World War II. . . .

With low growth, low birthrates and longer life expectancies,
Europe can no longer afford its comfortable lifestyle, at least not without a
period of austerity and significant changes. The countries are trying to
reassure investors by cutting salaries, raising legal retirement ages,
increasing work hours and reducing health benefits and pensions.

“We’re now in rescue mode,” said Carl Bildt, Sweden’s foreign
minister. “But we need to transition to the reform mode very soon. The ‘reform
deficit’ is the real problem,” he said, pointing to the need for structural
change.

The reaction so far to government efforts to cut spending has
been pessimism and anger, with an understanding that the current system is
unsustainable.

Greece:May
20 (Bloomberg) -- Thousands of Greeks marched through Athens today in the
fourth general strike of the year to protest planned pension cuts and other
austerity measures the government pledged to secure emergency European
financing to avoid default.

Police estimated that between 15,000 and 20,000 protesters
marched to parliament in central Athens, some waving banners that read, “Hands
off our pensions!” The strike was the first since three people were killed on
May 5 after demonstrators set fire to a bank in the capital. About 1,500 police
officers were deployed, with officers stopping protesters around Exarchia, a
stronghold of the anarchists police blame for the May 5 mayhem.

Thousands of Romanian trade unionists and pensioners took to
the streets to protest against public sector wage and benefit cuts on Wednesday
in a test of Bucharest’s resolve to pass austerity measures required by
international lenders.

Some 30,000 people rallied outside the government’s
headquarters in opposition to plans to cut public sector wages by 25 per cent
and pensions and unemployment benefits by 15 per cent.

PORTUGAL
- Union leaders have pledged to step up protests against the government's
austerity package. Prime Minister Jose Socrates and opposition leader Pedro
Passos Coelho have drawn up steps to slash Portugal's deficit, including 5
percent pay cuts for senior public sector staff and politicians. The deficit,
which stood at 9.4 percent in 2009, is to fall to 7.3 percent of GDP in 2010
and 4.6 percent in 2011 under the plan.

* SLOVENIA -
Thousands of students flooded the capital Ljubljana on Wednesday to protest
against government plans to curtail their benefits as part of a wider austerity
package.

-- The government of the euro zone member plans to limit
students' right to work, reduce state scholarships and lower state spending on
student meals as part of its plans to reduce a big budget deficit.

* SPAIN - Spanish
unions vowed on Thursday to fight austerity measures in the courts as the
Socialist government said it would introduce a contentious cut in public sector
wages through a royal decree, bypassing parliament.

-- The UGT union, which was already planning a public sector
strike on June 8, said it would contest the legality of such wage cuts at the
center of plans for budget reductions of 15 billion euros ($18.62 billion)
announced last week.

May 17, 2010

As regular readers know, we’ve been covering the building
European crisis here at the Lounge since
January, and have at times enlisted the help of a great group of sovereign
debt experts to write guest posts on particular issues of interest.

Frequent Lounge guest blogger Lee C. Buchheit
(Cleary Gottlieb) – see here,
here,
and here
for prior posts -- spoke with Bloomberg radio this weekend on the debt crisis
and, specifically, on how to restructure Greek debt.The interview is informative, both for those familiar with
the history and mechanics of sovereign debt crises, and for those with little prior
exposure to the topic, as Buchheit provides a brief and understandable primer
on some of the underlying legal, political, and economic issues.If the podcast below doesn’t work for
you, you can listen to the interview here.

May 16, 2010

This should be another interesting week for Europe.On Friday, the
euro fell to its lowest level in 18 months, world stock markets took a hit,
and there has reportedly
been a big sell-off in European periphery zone debt by large investors,
with ECB doing the buying (as announced as part of the bailout plan).According to sources quoted in the FT,
Pimco has sold all of its holdings in Greek and Portuguese sovereign debt.It also quotes an unnamed “head of one
of the largest US asset managers” as saying “We think it is too risky to buy
Greece and Portugal.The chance of
restructuring is too high.”

Ramin Toloui, a senior portfolio manager at Pimco, is also
quoted:

The European Central Bank’s decision to buy government debt
could be backfiring. Instead of encouraging private investors to keep their
government debt, the programme might be leading to more sales, he said.

“The risk is that investors are using the ECB as a vehicle to
exit their positions,” he said.

Now, maybe I’m dense, but I guess I don’t understand why
this is an unanticipated result. Though
Gelpern
doesn’t foresee a Greek restructuring in the near future, many
others do (John Dizard reports in his column yesterday that "most of the lawyers, bankers, and emerging market investors" predict a restructuring within six months to a year).And, given
the uncertainties associated with the “shock and awe” plan for the long term, surely
dumping Greek and Portuguese debt onto a willing ECB buyer if given a chance is
an attractive opportunity for some savvy investors unwilling to hold an asset
much riskier than the reasonably safe European debt they originally bargained
for?

Barry
Eichengreen also comments on the “unprecedented purchases of Spanish,
Portuguese, Greek, and Irish bonds by the European Central Bank,” noting:

rather than folding their cards, European leaders doubled
down. They understand that their gamble will be immensely costly if it proves
wrong. They understand that their political careers now ride on their massive
bet. But they also understand that they already have too many chips in the pot
to fold.

It’d be interesting to know exactly who was selling European
periphery sovereign debt (other than Pimco) last week, and whether there were
buyers other than the ECB.And how
long does ECB plan to buy and what will happen when they decide it’s time to stop?A trillion could go pretty quickly
under such conditions, it seems.

May 11, 2010

Now, it really is a party – and Adam
Feibelman joins the fun from Tulane law school. Not to be outdone by Anna,
Lee,
and Mitu,
his post comes complete with photos
of the Greek protest dog that has been seen at nearly every demonstration
in Athens over the last two years, including the recent
protests and riots against austerity measures. But Adam’s post also follows
a different tack from our prior posts on this crisis, which have largely
focused on the pros
and cons of the bailout, whether Greece should restructure
or pay up, and how the Greek
bond contract terms compare to those of other sovereigns who have
restructured. But Adam contends that
this discussion misses a crucial point: the looming sovereign debt and currency
crises highlight weak spots in the nascent international financial regulatory
apparatus.

Thanks to the folks at Faculty Lounge for letting me chime
in on Greece.Having devoured the excellent
commentary by Kim (most recently here,
here
and here),
Anna
Gelpern, Lee Buchheit
and Mitu Gulati, the various reliable financial writers, and the very
spotty financial reporting in mainstream news, I find myself a bit surprised by
the scope of the discussion.In
earlier phases of the ongoing global financial crisis, a significant amount of commentary
was directed at the need for reform of the relevant regulatory landscape.In fact, the rush toward regulatory reform at that time
seemed disconcerting.Now, hardly anybody seems to be
interested in what the Greek debacle and the Euro crisis might reveal about
financial regulation, especially regulation of the international monetary
system.

In fact, whatever their causes and solutions, the looming
sovereign debt and currency crises highlight some festering weak spots in the
nascent international financial regulatory apparatus, and they suggest some
aspects in need of innovation and/or reform.The current phase of crisis underscores the potential
benefits of a more robust form of systemic, multilateral surveillance and
regulation of monetary affairs.But
it also underscores the challenges that policymakers will face in designing an
effective multilateral regulatory apparatus for the global monetary system.

It is becoming increasingly clear that a significant part of
what made the Greek situation so difficult to avert, and now makes it so
difficult to resolve, is Greece’s membership in the European Monetary Union and
resulting triangular relationship between Greece, the International Monetary
Fund, and the European Monetary Union.While the Fund has long had formal authority to conduct surveillance of
Greece and to enforce Greece’s obligations with respect to exchange rate
policies and external stability, much of the relevant policymaking affecting
Greece is now done by regional institutions, over which the Fund has no formal
authority.

This scheme of overlapping regulatory domains poses many
hazards.It can dilute
accountability for individual institutions, which makes it dangerously easy for
well-recognized problems (like, say, atrocious data reporting) to go
unaddressed.Perhaps more
troubling, overlapping obligations and responsibility can pull in different
directions.As a number of
commentators have suggested, it appears that the EU is much more reluctant to
contemplate debt restructuring for Greece than is the IMF.If so, this may provide a rather stark
example of a significant tension between the economic and political interests
of the Euro zone and those of the rest of the world in promoting stability of
financial markets in general and the international monetary system in
particular. It at least
illustrates the potential for conflicting regulatory pulls.

Such tensions are not easily resolved, and they may prove
politically intractable.Yet
effective regulation of the international monetary system requires much clearer
articulation of priorities and authority.One of the express purposes of the Fund is to “oversee the international
monetary system to ensure its effective operation.” Throughout most of its history, the Fund has primarily done
this through its bilateral surveillance of its individual members.In recent years, however, the Fund and
many of its members have realized that it needs to shift at least some of its
activity toward a more robust multilateral surveillance and to become more
effective in promoting systemic monetary stability. But what should this entail?

At the very least, membership in the Fund should entail some
obligation to avoid creating or exacerbating vulnerabilities in the global
monetary system (this means you, U.S. and China).But the current crisis in Greece and the Euro zone suggest
that there may be a need for a more aggressive form of multilateralism.It suggests, for example, that the Fund
should engage more directly with non-member institutions – like, say, the ECB –
that exert significant influence over Fund members and, thereby, upon the
international monetary system.Given
the political economy of the Fund and its ongoing challenges to its legitimacy,
it seems unlikely that there is much appetite for such far-reaching
reformulation of the Fund’s mandate. If the EU is increasingly perceived to be gambling with
global economic and financial security to preserve itself, however, and if the
Fund is correspondingly viewed as the more reasonable and realistic international
actor, this appetite may grow.

One final point: The current debate over bailout versus
restructuring should also reinvigorate consideration of a sovereign debt
restructuring mechanism (which presumably would fall within the Fund’s
domain).One of the potential benefits
of an SDRM that tends to be underappreciated (and controversial) is that it
could – depending on how it is designed – generate relatively objective criteria
as to when restructuring is warranted, perhaps relieving some of the political
obstacles that are so easily discernable at present.

It’s a party!
And I’m the host. Granted,
it’s a sovereign crisis party that only six people in the world want to attend,
but one of them is Anna
Gelpern (American, law) back for another
guest post. If you’re in a
public setting, such as a meeting, where laughing out loud would be
inappropriate, then stop right here.
Otherwise, sally forth my fellow Greek crisis aficionados and read the
funniest post to emerge from the mess so far.

Gelpern:All right already, I feel like κραπ
enough without this!Look, my
basic problem is that I just do not see the endgame.Let’s say Greece announces a debt exchange today at 50 cents
on the dollar, and let’s say it takes six months to carry off.What happens to the Greek banks?What happens to the German banks, the
French nonbanks, the Belgian pet shops?What happens to Spain, Portugal, Ireland, the Euro?Do we even know who wrote the CDS on
this stuff?What if it is some
crazy corner of Pitygroup?What if
it is Grannie Mae?What if it is
China?What if China goes down????

Γκελπερν:This is the problem with you bailout
people—always the same scare tactics—contagion, externalities, extreme uncertainty,
Alien landings.And then the fat
cats who made stupid investments and fools who lived beyond their means all get
rescued, and us regular folks get stuck with the bill.The cats and the fools need to take
their lumps so they do not act stupid the next time.Ever heard of moral hazard?

Gelpern:You are speaking in generalities.“You always” is not an argument.

Γκελπερν:And you have been blowing scare
smoke.You want specific, here’s
specific – Ρουμπίνί says, “at the onset of its crisis, Argentina’s budget deficit, public debt,
and current-account deficit (as a share of GDP) were about 3%, 50% and 2%,
respectively. Those ratios for Greece are far worse: 12.9%, 120% and 10%.”There is no way Greece can avoid
restructuring.So why not do it
now for 50 cents?You are delaying
the obvious only to give the
creditors a 75 cent haircut, not to mention six months to three years of untold
pain for the Greek people – all for nothing.

Gelpern:We are both practicing economics
without a license.Κρουγκμαν
says the Greeks suffer no matter what.I am not saying 150% is sustainable, but let us not pretend
there is a magic number that tells you whether a country can pay.If there were, all the real economists
would not be arguing about sustainability and preconditions.I just worry that 50 cents will be more
like 90 cents if everything spins out of control.We have never had this sort of thing happen in a serious currency
block or with a G3 currency.…Besides, there is a big
difference between six months and three years.You were short Argentina in 1993.They defaulted in 2001.

Γκελπερν:So what is your endgame, exactly?Let me guess.Recapitalize the banks, amend the EU treaties to get a
common fiscal authority and financial resolution regime, wait until the markets
are pristinely calm, then ask nicely
for a 75% haircut?And what do you
think the creditors will do in the meantime?

Gelpern:You are right, it seems disingenuous.But my preconditions are no less
realistic than the next guy’s, and they are good policy besides.Just read the small print—everyone is
assuming rational behavior under standard temperature and pressure!Policy makers do not get that luxury;
we do not give them enough credit.

Γκελπερν:Snap out of it.Tell me what should happen.

Gelpern:Look, I’m sorry.I think the
trillion-dollar caper is probably the right thing to do, for both of
us.It makes a restructuring
easier if you decided to go for it—even if I still don’t know who could go down
with Greece, I know there is enough money to insulate whoever it might be.And I am sort of impressed with the IMF
angle.This must mean Asia and the
rest are on board.

It helps you, but it also makes it less likely that Greece
will have to default.Bonds don’t
run—they sell, drop or mature.And
if there is a sell-off, the guys who buy Greece at a discount now might not
mind a haircut quite as much later.So you are getting a bit of relief by the back door.

Γκελπερν:Is this worth a trillion dollars?

Gelpern:Well, I do not think they will actually
spend anything like a trillion.Remember all those “second lines of defense”
that never got drawn?

As everyone
knows by now, European leaders agreed on Monday to provide a huge rescue
package of nearly $1 trillion in an effort to stem the emerging European debt
crisis.This raises any number of
political, legal, and economic questions about Europe, the world economy more
generally, and the potential impact on the U.S.

But leaving aside such big-picture issues for the moment, does
it resolve the issue that first prompted the crisis (and
our interest in it here at the Lounge) to begin with?Namely, should Greece restructure its
debt now (or at least very soon), forcing creditors to take a haircut, or
should it muddle through and attempt to make current payments, accepting making the
severe austerity and other measures that come along with this bailout
package even more painful?

In this context it’s worth noting that Simon Johnson, who
used to be the IMF’s chief economist, says that the Fund “floated in some
fashion an alternative scenario with a debt restructuring, but this was
rejected by both the European Union and the Greek authorities”. What that means
is that the idea is being seriously talked about at the highest levels — and
that even if the Greek government isn’t going to crack right now, it has a
clear “in case of emergency, break glass” Plan B temptingly sitting there for
whenever the pain of recession becomes unbearable. With Lazard on board as
sovereign advisors, a clear plan of action from Buchheit and the IMF
comfortable in principle with a default, the path of least resistance is quite
clear.

Today, John Taylor
appeared on Squawk Box (video embedded below) to discuss the European
situation, arguing that the bailout is likely to simply “delay the inevitable”
and urging an early and orderly restructuring of Greek debt.

May 10, 2010

European leaders agreed on Monday to provide a huge rescue
package of nearly $1 trillion in a sweeping effort to combat the debt crisis
that has engulfed Europe and threatened markets around the world, James Kanter
and Landon Thomas Jr. write in The New York Times.

For the moment, the market is thrilled, but we shall see
what the longer-term brings.

May 09, 2010

A
few days ago, I asked when Greece would restructure and noted that the
emerging consensus seems to be that they will eventually have to do so.The real question is “when”?Well, the other question is “how?” and Lee
Buchheit (Cleary Gottlieb Steen & Hamilton) and Mitu Gulati (Duke, law) have the
answers in a
paper just posted to SSRN (I mean really
just posted, like 5 minutes ago).

A few key points about Greek debt generally, from the paper:

Þ
Greece’s total debt as of end-April 2010 was approximately €319 billion.Of that figure, the vast majority --
approximately €294 billion -- was in the form of bonds.

Þ
Virtually all of this debt was denominated in Euros.Small amounts (in aggregate, less than 2% of the total) are
outstanding in U.S. dollars, Japanese yen and Swiss francs.

Þ The
extent of retail (non-institutional) ownership appears to be small.

Þ 90%
of the total is governed by Greek law.Only about €25 billion of the bond debt was issued under the law of
another jurisdiction -- most of that under English law.

Þ It
does not appear that the instruments issued under local law contain provisions
permitting the holders to amend the terms of the bonds after issuance (other
than to correct obvious errors or technical matters) – in other words, they do
not appear to contain Collective Action Clauses.

Þ Greece
does not appear to have included a negative pledge clause in its bonds issued
under local law.Although Greek
foreign law bonds do contain negative pledge clauses, they would only be
triggered in bonds issued between 2000-2004 by the creation of a lien to secure
a non Euro-denominated Greek debt.

Þ A
payment default on a Greek Euro-denominated bond issued between 2000-2004, or
the acceleration of such an instrument, would not have cross-default
consequences across the rest of the debt stock.

According to Buchheit and Gulati, the fact that so much of
the outstanding Greek debt is expressly governed by Greek law (90% or more,
they estimate) is an incredible advantage should Greece restructure, as it raises
the possibility that the restructuring could be facilitated in some way by a
change to Greek law.This
possibility is fraught with danger, however, and Buchheit and Gulati discuss
mechanisms for minimizing those dangers.

The biggest impediment to restructuring, according to the
authors, is the fact that such a large percentage of Greek debt is held by
Greek institutions and European banks. In contrast, sovereign debt crises of
the last 10 years or so have affected mostly non-bank creditors -- hedge funds,
pension funds, other institutional holders of emerging market sovereign debt,
sometimes even individuals.Those
crises did not threaten the stability of the banking sectors in creditor
countries (including the issuing country).

Buchheit and Gulati estimate that a Greek restructuring
could be accomplished in six months -- perhaps less, if done efficiently.They propose an exchange offer under
which the terms of the new instruments will be a function of the nature and
extent of the debt relief the transaction is designed to achieve. If some of
the emergency financing were to be used for this purpose, Greece might be able
to enhance the attractiveness of the new bonds it would offer in the exchange
through the use of credit enhancements.

The paper goes into great detail about all of this, of
course, and draws lessons, analogies, and differences from prior
restructurings, including Uruguay, Argentina, Mexico, Brady Bonds, Russia, and
others.The wimpy authors are
avowedly agnostic on the question of whether or not Greece should restructure, but if you’re looking for a roadmap on howthis is it.

May 06, 2010

In my last
post on this topic, I noted that Greece had accepted the terms of an
unprecedented bail out, but questioned whether that meant we’re done with the
whole mess now.I suggested that
we were not, for several reasons.

Since then, social
unrest in Greece, in anticipation of the austerity measures, has
increased.Three people choked to
death in Athens when rioters set fire to a bank as part of a protest against
the wage and pension cuts agreed to in concession for the EU/IMF bailout.Strikes also shut down Greek airports,
tourist sites and public services.50,000 demonstrated against planned public spending cuts and tax
increases.

As I’ve said several times now, I don’t see how these
austerity measures can be successfully implemented.The problem is more than an economic or legal one, but a
social and political one.

Consensus seems to be emerging now that Greece will indeed be
forced to restructure.The only
question is when. For example, both Ken
Rogoff and Martin
Wolf believe that a restructuring is likely.Paul Krugman
goes further: Greece is likely to restructure and also to leave the Euro.

Query: if that’s the case, then why put off the
inevitable?Is it better to
restructure now, rather than later, before things potentially get worse? I may
return to that question in a future post, or see if I can encourage our
informal counsel of sovereign debt experts to address it.

Naturally, these developments serve to fan the contagion
fears that have been circulating for some time.For now, I’ll leave you with those thoughts and the visual
below, courtesy
of the FT.Though the chart is
somewhat hard to read, and scary as that giant Greek spike is, perhaps the
place to focus now is on the lower lines just starting to separate themselves
from the pack, especially Portugal.

May 02, 2010

Greece accepted an unprecedented bailout from the European
Union and International Monetary Fund valued at more than 100 billion euros
($133 billion) to prevent default, agreeing to budget cuts that unions called
“savage.”

The measures are worth 30 billion euros, or 13 percent of
gross domestic product, and include wage cuts and a three-year freeze on
pensions, Finance Minister George Papaconstantinou said in Athens today.
Greece’s main sales tax rate will rise to 23 percent from 21 percent.

So are we done now?Game over?I suspect not,
and am left with even more questions now than when we began this endeavor four
months ago.Hopefully, our
informal counsel of sovereign debt experts will be willing to convene one last
time to answer some of them.

1.1. Where does this leave the other PIIGS (make
that PHIIGS) now? Yields surged on Portugal, Spain, and Hungary last
week.And it’s not clear that the
Greek bailout should magically restore market confidence in those countries’
ability to repay.Will another European
shoe drop later down the road?(I’ll
leave aside non-European high-income countries for the moment, such as Japan,
whose debt is projected
to climb to 227 per cent of GDP by the end of next year.)

2. 2. If so, what does that mean for the European Monetary
Union?Presumably, engineering a
bailout for another country sometime down the road will be even harder, as both
an economic and a political matter, than this one was.After all, Germany, the IMF, and everyone
else who participated in this bailout will have less money to spare now, and domestic
political opposition, particularly in Germany, has been intense.

3. 3. Can Greece even implement these severe austerity
measures?Bear in mind that this a
country in which one
out of every three people is employed in the civil service, which until now
has guaranteed jobs for life, and each prior mention of austerity measures has prompted
massive nationwide strikes and protests. Notably, there has
been no mention yet of whether the government would relax rules on laying
off public workers.To make
matters worse, it appears that the rich have been
avoiding taxes to the tune of $30 billion a year, which can’t sit well with
the Greek working class, who perceive (no doubt correctly) that they’ll bear
the brunt of any austerity measures.

4. 4. Finally, what is the Greek economy supposed to
look like at the end of three years when the aid runs out?Can the economy really grow in the face
of such severe cuts?Or is this just
a short-term (and expensive) fix?For
those wanting a more in-depth history of the Greek economy, Tyler
Cowen linked yesterday to a paper documenting when the Greek economy
started downhill, The Two Faces of Janus: Institutions, Policy
Regimes and Macroeconomic Performance in Greece, George
Alogoskoufis, Economic Policy, Vol. 10, No. 20
(Apr., 1995), pp. 149-192. (The ungated copy is here).

May 01, 2010

French Economy Minister Christine Lagarde said she expected a
package of 100-120 billion euros ($133-$160 billion) to help Greece out of its
debt crisis, and had "good hopes" a deal could be reached by the end
of this weekend. . . .

But a bailout will come in return for draconian budget cuts
in Greece, where thousands marched on May Day shouting slogans against
austerity measures they say only hurt the poor and will drag the country
further into recession.

"No to the IMF's junta!," protesters chanted,
referring to the military dictatorship which ruled Greece from 1967 to 1974.
"Hands off our rights! IMF and EU Commission out!," the protesters
shouted as they marched to parliament. . . .

Greece's public sector union has also called a 4-hour strike
for Tuesday, on top of a nationwide strike set for Wednesday, highlighting the
challenge the government faces in pushing through the cuts it has promised
potential lenders.

What’s that old saying about starting to scream as soon as
you see the dentist’s drill?I
don’t see how this can inspire confidence in Greece’s ability to deal with its
failing economy.

At the same time, a growing number of voices are calling for
a preemptive restructuring, rather than attempting to meet existing debt
obligations.For example, Nouriel
Roubini and Arnab Das in
the FT argue:

The past weekend’s spring meetings of the International
Monetary Fund in Washington focused on the Greek sovereign debt crisis – the
first such crisis in living memory to concern a high-income country, and in the
eurozone no less. Even more telling than the shift of focus from emerging
markets is the widening divide in the views of those institutions and
governments leading efforts to secure an orderly resolution.

Roubini and Das urge a pre-emptive debt restructuring for Greece
– continuing on the current path risks a disorderly default and financial
crisis. Lee Buchheit
made a similar point in his
guest post here a few days ago.

Moreover, consensus seems to be building around the notion
that the crisis has not been handled well.For example, in the
WSJ Stephen Fidler And Marcus Walker argue that:

As the International Monetary Fund and euro-zone governments
finalize their debt rescue package for Greece, there is wide agreement on at
least one thing: European governments could hardly have managed it worse if
they had tried.

Euro-zone governments, held back above all by a reluctant
Germany, have taken so long to arrange financial support for Greece that its
debt crisis is turning into a wider European conflagration that threatens
Portugal, Spain and potentially other indebted countries.

Finally, Felix
Salmon reports that Greece is rumored to have already hired restructuring
advisors (Lazard).If that’s true,
then things may get interesting very soon.

April 26, 2010

As I noted in my
last post on this topic, this week will be an important one for the
European monetary union.So I asked
the Lounge’s informal counsel of sovereign debt experts for their views on what
sorts of questions we should be asking now that Greece has asked for aid, and
the market still appears unappeased.Mitu Gulati (Duke) started
us off by asking some pointed questions about the terms of the Greek bond
contracts, arguing that, when times are good no one cares about the
contracts.But, he says, things
look bad enough now that these issues should matter to debtholders (and to
Greece).Below, Lee C. Buchheit, a partner based
in the New York office of Cleary Gottlieb Steen & Hamilton LLP, joins the
fray:

At this point, it is worth asking how the "no debt
restructuring" scenario is supposed to play out.

Is the theory that Greece will draw down on the EU/IMF
bailout money to cover maturing debt obligations and budget deficits while the
fiscal adjustment takes hold and, at some point in the not-too-distant future,
the markets will be prepared to resume lending at moderate coupons?

If so, a couple of observations:

The bailout fund will need to be larger than EUR 45
billion.Once the country starts
suckling on the bailout fund, it may be some time before it can be weaned.

The market's nostrils are visibly flaring with the whiff of
debt restructuring on the air.They will not, I suspect, be easily or quickly persuaded that the crisis
has passed.

The worst case scenario here is one in which the bailout
money is exhausted in an effort to "brass it out" (as the English
say), only to find that a debt restructuring cannot in the end be avoided.Why?Because those resources might have been used in some
creative way to facilitate the debt restructuring (remember Brady Bonds?), or
at the very least to backstop the local deposit insurance scheme or
recapitalize local banks that are adversely affected by the restructuring.A sovereign debt restructuring
with no fresh money behind it is both a harder and an uglier thing to complete.

This then is the dilemma of the moment.Should the bailout money be spent
paying maturing debt obligations in full and on time until it is exhausted, or
should it be husbanded and used to support a debt restructuring of some kind?

One is reminded of Winston Churchill's verdict on Neville
Chamberlin's policies in 1939:

"You were given the choice between war and
dishonor.You chose dishonor and
now you will have war".

April 25, 2010

With predictions
that this week will be the most important one in the history of Europe’s
monetary union, I thought that the time was ripe to ask the Lounge’s
informal counsel of sovereign debt experts for their views. Below is the response from Mitu Gulati (Duke).

The Eurozone bailout fund for Greece has not calmed the
concerns that the markets have about Greece’s ability to repay its debts.Increasingly, commentators are
recognizing that a restructuring of the Greek sovereign debt is likely, if not
inevitable.Wolfgang Munchu of the
FT said this in last week in a piece titled “Greece’s
Bailout Only Delay’s the Inevitable”.Today, Jack Ewing of the New York Times was saying much the same, in “For
Greece, Restructuring is No Longer Unthinkable”. In effect, this means that Greece is going to ask for
financial support not only from the Official Sector (the Eurozone and the IMF),
but also from its private creditors (in the form of the proverbial
“haircut”).Private creditors
though rarely take debt haircuts willingly.Typically, they fight hard to preserve their hair.The question of how (and whether) they
can be forced to take a haircut then will depend on what the Greek debt
contracts say.And, if that is the
case, why are none of these commentators who think that a default is in the
offing talking about what those contracts say?

Looking at the contracts, in theory, should be useful in
determining what a Greek debt restructuring would look like.First and foremost, there are these
things called Collective Action Clauses.In 2003, they were all the rage in Washington D.C.The US Treasury promoted them aggressively
as a cure to the problem of Official Sector bailouts.Prior to the introduction of these clauses it used to be
very difficult (at least for US law governed bonds) to get a sovereign
restructuring done because the contracts typically required 100% of the
bondholders to agree before there could be any alteration of payment terms
(including stretching out the time of payment).In effect, the unanimity requirement meant that agreement
could never be reached and, therefore, Official Sector bailouts ended up being
the only solution.These
Collective Action Clauses or CACs, however, would require something between 75%
and 66% vote for an alteration of payment terms.The idea was that sovereigns who used these clauses would be
able to go to their private creditors and ask for a debt reduction.If the deal was good enough to persuade
the relevant fraction of holders, the rest of the holders would be bound.Voila! No more need for big Official
Sector bailouts.

If CACs obviated the need for big Official Sector bailouts,
why is no one asking about Greece’s CACs?Even the US Treasury, that took all the credit for introducing these
CACs in 2003, is not talking about them.As of yesterday, Treasury Secretary Geithner seemed to be encouraging
Greece to do everything necessary to go in the direction of the Official Sector
bailout. See Andrew Beatty, Pressure
Mounts for Swift Greek Bailout, Yahoo News.

But assuming that the commentators such as Munchu and Ewing are
correct, as I suspect they are, that the Official Sector bailout is not going
to be enough, the question of what kind of CAC clauses Greece used in its
contracts will have to be asked.If Greece issued primarily under UK law (from my brief examination of
some of the contracts available on public databases such as Thomson, Greece
issued at least some of its debt under UK law), then it probably has CACs in many
of its debt contracts.That, in
turn, means that if it can persuade somewhere between 75% and 66% (depending on
the specific clauses it used) of the bonds in principal amount that it is in
their interest to agree to a restructuring where payment terms are stretched
out a few years, Greece can get itself some relief directly from its creditors.If the alternative for those creditors is
that Greece defaults, its government falls, Spain and Portugal also default,
their governments fall, and that there is generally financial mayhem
everywhere, surely at least the big creditors (who probably also own Spanish,
Portugese and other sovereign debt) will at least consider the possibility that
it might be best to allow Greece a few more years on its payments.The specific vote requirement in the
contracts, however, will be crucial in determining how easy it is for Greece to
get agreement on its restructuring plan.

Further, many of the standard UK law sovereign contracts
mandate that there be a meeting of the bondholders where the vote takes
place.This can be good and bad
for Greece.On the one hand, it is
bad if Greece offers the holders a crappy deal and fears that allowing the
creditors to meet and talk might induce them to form a united front against the
proposed restructuring.On the
other hand, the meeting provision can be good in that it typically comes with a
quorum requirement.If the quorum
(let us assume it is 50%) is not met, then a subsequent meeting will be called
where the quorum requirement is reduced (in effect, meaning that the vote
required for the restructuring is even lower – in theory, Greece could do its
restructuring with less than a 30% vote).

Nothing I have said should come as news to the debt experts
at the IMF, the ECB, the legal departments of the big creditor institutions
like PIMCO and (hopefully) in Greece’s external debt management office.The fact that we have not heard a peep
about the contracts from these experts and the reporters they talk to makes me
suspicious that there is something wrong.Maybe the Greek CACs don’t work for some reason? I remember the guru of
sovereign debt contracts, Lee Buchheit, once saying something along the lines
of: “no one looks at debt contracts until they are staring at the abyss”.My question to Lee now is:In Greece’s cases, haven’t we been
staring at the abyss for some weeks, if not months, now?

And it is not just the CACs that the smart money should be
interested in now.There are other
questions that Greece’s legal advisers should be asking.For example, can Greece promise
creditors a security interest in its gold reserves, for example, in exchange
for a lower rate of interest?Typically, such a move would be prohibited by the standard negative
pledge clause.But maybe Greece’s
negative pledge clauses allow some leeway?Alternatively, Greece could promise new creditors revenues
from certain streams of tax revenues.Those promises, if not barred by the negative pledge and pari passu
clauses, could also produce new debt at a lower interest rate for Greece.A third question is What portions of
its debt can Greece stretch out the payments on without triggering cross
default clauses in its other bonds?The answer to this question will depend on how the cross default clauses
were drafted (and, typically, the definition of External Indebtedness in
them).And so on and so
forth.Again, I’m back at the question
that I started with.Why are the
experts not talking about the terms in these contracts?

I asked him [Lee] about The New
York Time’s report that European leaders sought “to quash any doubts about
their resolve to help Greece,” by offering a one-year aid package of up to €30
billion. Isn’t this so far removed, I asked, from what Greece actually
needs to make a go of it that it’s just throwing money away? Why do
this? Do they really think that’s enough? Or is this just a
political move designed to make it look like Europe actually tried to do
something, rather than standing by watching Greece tank? Is there something
here that I don’t see? In response, Buchheit told me The Parable
of the Second Engine:

Some years ago my brother started to take flying lessons. He
trained on a single-engine aircraft.

"But surely brother mine", I said to him one fine day,
"it is safer to train on a two engine aircraft in case one engine
stalls".

"Lee", he responded in that tone of voice employed by all
elder brothers when speaking to their siblings, "if one engine were to
stall in an aircraft being flown by an inexperienced pilot, there are so many
adjustments the pilot would have to make all at once that the utility of the
second engine will merely be to fly everyone to the scene of the crash".

This 30 billion, and even perhaps the 30 billion after that, may wind
up performing the function of the second engine.